Portfolio Theory Part 3

Question 1

Security Market Line

Answer 1

Graphical representation of CAPM

x-axis: B
y-axis: E[R]
y-int: risk free asset

Question 2

Aggressive Beta

Answer 2

high beta stock with more room for loss

usually common with goods tied to the economy e.g. home buying

Question 3

Defensive Beta

Answer 3

low Beta stock, safer

beverages, food, more necessity goods

Question 4

Levered Beta

Answer 4

Beta with debt

As beta-L increases firm will be more sensitive to the market

Question 5

Capital Market Line

Answer 5

Line between risk free asset and the market

Demonstrates the efficient frontier

Question 6

Beta < 0

Answer 6

implies more diversification as asset moves opposite the market

Question 7

Evidence in support of CAPM

Answer 7

It is true that;

In up years high beta stocks > low beta stocks

In down years low beta stocks > high beta stocks

Question 8

Evidences in doubt of CAPM

Answer 8

1. actual and theoretic relationship between Beta and return diverge, especially in short periods
2. beta is unstable
3. beta is easily rolled over (beta changes depending on different measures)
4. 0 beta return is above risk free rate
5. B<1 stocks do better than predicted

Question 9

Arbitrage Pricing Theory

Answer 9

Steven Ross

Stock returns are influenced by several independent factors, but it DOES NOT specifically state what the factors are

Question 10

Fama-French Variables

Answer 10

2 characteristics describing the most variation in security returns:

1. firm size
   2, book to market ratio